Futures and Options (F&O) Trading: Meaning, Differences, Tax Implications, and Other Key Concerns
Updated: Oct 29
F&O, short for futures and options, is a popular trading segment that offers significant earning potential but also involves complex tax implications. Taxpayers engaged in F&O trading must understand that futures and options trading income is categorized as business income. This requires careful filing under the correct tax head and following specific tax rules.
If you’re into futures and options trading, understanding the tax rules is crucial. Gains or losses from F&O trading must be reported under business income, requiring accurate filing and record-keeping. In this article, we’ll cover everything from tax filing requirements to key benefits, making it easy for F&O traders to stay compliant.
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Budget 2024 Update
To expand the tax base, the Securities Transaction Tax (STT) on futures and options trading is set to increase. STT for futures is now proposed at 0.02%, while STT on options will go up to 0.1%. Additionally, income received from share buybacks is proposed to be taxable in the hands of the recipient.
What are Futures and Options (F&O) and How Do They Work?
Futures and Options (F&O) are derivatives that allow traders to speculate on the future price of an asset. Here’s a quick breakdown:
Futures: A futures contract is an agreement to buy or sell an asset at a predetermined price on a specific date. Both parties are legally obligated to fulfill the contract, whether there’s a profit or loss.
Options: An options contract provides the right, but not the obligation, to buy or sell an asset at a specified price before the contract’s expiration date. This flexibility allows option buyers to exit the trade, minimizing losses when market conditions turn unfavorable.
F&O trading includes various forms like equity F&O, commodity F&O, and currency F&O. Understanding the basics of what is futures and options trading is crucial before diving into the tax implications.
How to Report Income from F&O Trading in India
F&O trading income is classified as non-speculative business income under Section 43(5) of the Income Tax Act. This classification means you must report futures and options income under Profits and Gains from Business or Profession (PGBP) in your tax return.
Which ITR Form to Use for F&O Income?
If you are an individual involved in F&O trading, you should file ITR-3 since it’s designated for individuals earning business income. Using the correct ITR form ensures that F&O trading gains or losses are reported accurately.
Tax Rules for Different Types of Trading Beyond F&O
Many taxpayers diversify their investments, trading not only in futures and options but also in intraday trading and long-term equity investments. Here’s how the taxation rules differ:
Intraday Trading: This is treated as speculative business income due to the high risk and lack of delivery. Income from intraday trading is taxed separately from F&O trading income.
Short-term Equity Investments: When short-term equity trades are frequent and substantial, they can be treated as business income. Otherwise, they’re classified as capital gains.
Long-term Equity Investments: Long-term investments are generally considered capital gains unless frequent trading indicates a business activity.
Record-Keeping Requirements for F&O Traders
If you’re involved in futures and options trading, maintaining proper accounting records is essential, as it’s regarded as a business.
Thresholds for Accounting Records: If your income from F&O trading exceeds INR 2.5 lakh, or if your turnover crosses INR 25 lakh, you’re required to maintain accounting records.
Necessary Documents: For F&O trading, keeping a record of trading statements, expense receipts, and bank account statements should be enough to meet compliance requirements.
Calculating Turnover for F&O Trading
Turnover for futures and options trading is calculated as the absolute profit, which combines positive and negative trade differences. Here’s an example:
Suppose Aditya buys 100 units of futures at INR 200 and sells them at INR 210. He also buys 200 units of options at INR 300 and sells them at INR 290. The turnover calculation will look like this:
Particulars | Calculation | Amount |
Futures | (210 - 200) * 100 | 1,000 |
Options | (290 - 300) * 200 (negative) | 2,000 |
Total Turnover (Absolute Profit) | 3,000 |
This absolute profit approach is essential for determining whether a tax audit is needed.
When is Tax Audit Required for F&O Trading?
A tax audit for futures and options trading under Section 44AB depends on your trading turnover and profit levels.
Turnover up to INR 2 Crore:
A tax audit is required if the profit is below 6% of turnover, your income exceeds the exemption limit, and you have opted out of presumptive taxation in the past five years.
If your profit is 6% or higher of the turnover, no audit is required.
Turnover Between INR 2 Crore and INR 10 Crore:
If digital transactions exceed 95%, a tax audit is not required for turnovers between INR 2 crore and INR 10 crore.
Turnover Above INR 10 Crore:
A tax audit is mandatory, irrespective of profit or loss.
How to Carry Forward F&O Losses
If you incur losses in F&O trading, filing your ITR allows you to carry forward these losses and offset them against future gains. Here’s how it works:
Carry Forward Period: F&O losses can be carried forward for up to eight years and offset against other non-speculative income in the following years.
Set-off Rules: As futures and options trading is non-speculative, losses can only be set off against other non-speculative income, not against speculative income.
For instance, losses from futures and options in one year can reduce taxable profits from other non-speculative businesses in subsequent years.
Claiming Business Expenses for F&O Trading
Yes, F&O traders can claim business expenses related to futures and options trading. These can include:
Brokerage Fees and Transaction Charges
Subscription Costs for trading resources
Internet and Telephone Bills related to trading
Consultancy Fees if professional advice is sought
Make sure to keep all receipts and evidence of these expenses, especially if they are digital transactions. Expenses above INR 10,000 paid in cash may not qualify for deductions.
Example of Expense Deduction:
Suppose Aditya, an F&O trader, has brokerage fees totaling INR 98,000, along with internet and phone costs directly linked to trading. These expenses reduce his total taxable income, so reporting them accurately is essential for lowering tax liability.
Old vs New Tax Regime for F&O Traders
F&O traders can choose between the new tax regime under Section 115BAC or stick to the old regime. Here are some key considerations:
New Tax Regime: This regime is based on slab rates but does not allow Chapter VI-A deductions (for example: 80C, 80D).
Old Tax Regime: Offers more deductions but requires adherence once chosen, with only one lifetime option to switch back.
FAQ
Q1. What are futures and options (F&O)?
Futures are contracts to buy or sell an asset at a future date, while options allow buying or selling at a fixed price, providing flexibility for the buyer.
Q2. Why must F&O income be reported as business income?
F&O trading is non-speculative business income, so it must be reported under Profits and Gains from Business or Profession (PGBP).
Q3. Which ITR form should I use for F&O trading income?
You should file ITR-3 for futures and options trading income, as it’s designated for business income.
Q4. Can I carry forward losses from F&O trading?
Yes, F&O trading losses can be carried forward for eight years, offsetting future non-speculative income.
Q5. Do I need to maintain records for F&O trading?
Yes, if your F&O income is over INR 2.5 lakh or turnover exceeds INR 25 lakh, you must keep records of all related transactions.
Q6. How is turnover calculated for F&O trading?
Turnover is calculated by adding absolute profits from all trades, including positive and negative trade differences.
Q7. Is tax audit necessary for F&O traders?
Tax audit depends on turnover and profits. A tax audit is required for turnovers over INR 10 crore or if profits are under 6% with turnover under INR 2 crore.
Q8. What expenses can F&O traders deduct?
F&O traders can deduct expenses like brokerage, internet, telephone, and consultancy fees related to futures and options trading.
Q9. Should F&O traders choose the new tax regime?
F&O traders need to consider the absence of deductions in the new regime against the possible benefits of simplified tax slabs.
Q10. How does the new tax law affect F&O traders’ ability to carry forward business losses?
The new tax regime does not allow F&O traders to carry forward business losses, which impacts tax planning and may affect future tax liabilities.
Q11. Is ITR-3 the only applicable form for F&O traders, or can they choose other ITR forms?
ITR-3 is specifically designed for non-speculative business income, which includes F&O trading. Using the correct form is essential for compliance and accuracy.
Q12. What are the tax audit requirements under Section 44AB(e), and how does F&O turnover impact this?
Section 44AB(e) mandates a tax audit for F&O traders with turnover beyond specific limits and profit or loss under 6%, particularly if they’ve opted out of presumptive taxation in the previous five years.
Q13. Are there unique rules for F&O traders handling advance tax payments, particularly under Section 44AD?
Yes, F&O traders using Section 44AD must pay advance tax in a single payment by March 15 to comply with presumptive taxation, simplifying their tax obligations for the year.
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